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This is a question/answer from the BPP Booklet: As i understand, we should not use depreciation as a cash inflow.
NW Co is considering investing $46000 in a new delivery van that will last for 4 years after which it will be sold for $7000. Depreciation is charged on a straight line basis. Forecasted operating profits/losses are as follows:
year $
1 16500
2 23500
3 13500
4 (1500)Assuming cash flows arise evenly throughout the year, what is the payback period for the investment? Options are 1y7mth, 2y7mth, 1y5mth, 3y,2mth
The answer shown is 1y7mths, and is calculated as follows:
Time Profit Depreciation Cash Flow Cum Cash FL
0 Investment (46000) (46000)
1 Cash Inflow 16500 9750 26250 (19750)
2 Cash Inflow 23500 9750 33250 13500The necessary fraction of the year is taken.
Any thoughts? Is this correct, or did I misunderstand how to calculate payback periods?
My calculation shows 2years, 5 monthsIn future you must ask in the Ask the Tutor Forum if you want me to answer. This forum is for students to help each other 🙂
The answer is correct. The profits will be after charging depreciation. Depreciation is not a cash flow and so to get the net cash receipt we need to add back the depreciation.
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